History 101

Douglas MacArthur brought some American Institutions into Japan and unleashed a lot of Human Capital

At the end of World War I the allies really screwed the Germans. The Treaty of Versailles made for an impossible peace. In a war that had no innocents the Allies heaped all blame onto Germany in the end. And the bankrupt Allies wanted Germany to pay. Placing impossible demands on the Germans. Which could do nothing but bankrupt Germany. Because, of course, to the victors go the spoils. But such a policy doesn’t necessarily lead to a lasting peace. And the peace following the war to end all wars wasn’t all that long lasting. Worse, the peace was ended by a war that was worse than the war to end all wars. World War II. All because some corporal with delusions of grandeur held a grudge.

The Americans wouldn’t repeat the same mistake the Allies made after World War II. Instead of another Versailles Treaty there was the Marshal Plan. Instead of punishing the vanquished the Americans helped rebuild them. The peace was so easy in Japan that the Japanese grew to admire their conqueror. General Douglas MacArthur. The easy peace proved to be a long lasting peace. In fact the two big enemies of World War II became good friends and allies of the United States. And strong industrial powers. Their resulting economic prosperity fostered peace and stability in their countries. And their surrounding regions.

MacArthur changed Japan. Where once the people served the military the nation now served the people. With a strong emphasis on education. And not just for the boys. For girls, too. And men AND women got the right to vote in a representative government. This was new. It unleashed a lot of human capital. Throw in a disciplined work force, low wages and a high domestic savings rate and this country was going places. It quickly rebuilt its war-torn industries. And produced a booming export market. Helped in part by some protectionist policies. And a lot of U.S. investment. Especially during the Korean War. Japan was back. The Fifties were good. And the Sixties were even better.

By the End of the Seventies the Miracle was Over and Japan was just another First World Economy

Helping along the way was the Ministry of International Trade and Industry (MITI). The government agency that partnered with business. Shut out imports. Except the high-tech stuff. Played with exchange rates. Built up the old heavy industries (shipbuilding, electric power, coal, steel, chemicals, etc.). And built a lot of infrastructure. Sound familiar? It’s very similar to the Chinese economic explosion. All made possible by, of course, a disciplined workforce and low wages.

Things went very well in Japan (and in China) during this emerging-economy phase. But it is always easy to play catch-up. For crony capitalism can work when playing catch-up. When you’re not trying to reinvent the wheel. But just trying to duplicate what others have already proven to work. You can post remarkable GDP growth. Especially when you have low wages for a strong export market. But wages don’t always stay low, do they? Because there is always another economy to emerge. First it was the Japanese who worked for less than American workers. Then it was the Mexicans. Then the South Koreans. The three other Asian Tigers (Hong Kong, Singapore and Taiwan). China. India. Brazil. Vietnam. It just doesn’t end. Which proves to be a problem for crony capitalism. Which can work when economic systems are frozen in time. But fails miserably in a dynamic economy.

But, alas, all emerging economies eventually emerge. And mature. By the end of the Seventies Japan had added automobiles and electronics to the mix. But it couldn’t prevent the inevitable. The miracle was over. It was just another first world economy. Competing with other first world economies. Number two behind the Americans. Very impressive. But being more like the Americans meant the record growth days were over. And it was time to settle for okay growth instead of fantastic growth. But the Japanese government was tighter with business than it ever was. In fact, corporate Japan was rather incestuous. Corporations invested in other corporations. Creating large vertical and horizontal conglomerates. And the banks were right there, too. Making questionable loans to corporations. To feed Japan Inc. To prop up this vast government/business machine. With the government right behind the banks to bail them out if anyone got in trouble.

As the Eighties dawned the service-oriented sector (wholesaling, retailing, finance, insurance, real estate, transportation, communications, etc.) grew. As did government. With a mature economy and loads of new jobs for highly educated college graduates consumption took off. And led the economy in the Eighties. Everyone was buying. And investing. Businesses were borrowing money at cheap rates and expanding capacity. And buying stocks. As was everyone. Banks were approving just about any loan regardless of risk. All that cheap money led to a boom in housing. Stock and house prices soared. As did debt. It was Keynesian economics at its best. Low interest rates encouraged massive consumption (which Keynesians absolutely love) and high investment. Government was partnering with business and produced the best of all possible worlds.

But those stock prices were getting way too high. As were those real estate prices. And it was all financed with massive amounts of debt. Massive bubbles financed by massive debt. A big problem. For those high prices weren’t based on value. It was inflation. Too much money in the economy. Which raised prices. And created a lot of irrational exuberance. Causing people to bid up prices for stocks and real estate into the stratosphere. Something Alan Greenspan would be saying a decade later during the dot-com boom in the United States. Bubbles are bombs just waiting to go off. And this one was a big one. Before it got too big the government tried to disarm it. By increasing interest rates. But it was too late.

We call it the business cycle. The boom-bust cycle between good times and bad. During the good times prices go up and supply rushes in to fill that demand. Eventually too many people rush in and supply exceeds demand. And prices then fall. The recession part of the business cycle. All normal and necessary in economics. And the quicker this happens the less painful the recession will be. But the higher you inflate prices the farther they must fall. And the Japanese really inflated those prices. So they had a long way to fall. And fall they did. For a decade. And counting. What the Japanese call their Lost Decade. A deflationary spiral that may still be continuing to this day.

As asset prices fell out of the stratosphere they became worth less than the debt used to buy them. (Sound familiar? This is what happened in the Subprime Mortgage Crisis.) Played hell with balance sheets throughout Japan Inc. A lot of debt went bad. And unpaid. Causing a lot problems for banks. As they injected capital into businesses too big to fail. To help them service the debt used for their bad investments. To keep them from defaulting on their loans. Consumption fell, too. Making all that corporate investment nothing but idle excess capacity. The government tried to stop the deflation by lowering interest rates. To stimulate some economic activity. And a lot of inflation. But the economy was in full freefall. (Albeit a slow freefall. Taking two decades and counting.) Bringing supply and prices back in line with real demand. Which no amount of cheap money was going to change. Even loans at zero percent.